3.2 Agency Securities

Agency vs. Government-Sponsored Enterprise

Federal agency securities are debt instruments issued by entities created by Congress to support housing, agriculture, and other policy goals. The Series 7 hinges on one distinction: a true government agency carries the full faith and credit of the United States, while a government-sponsored enterprise (GSE) is a privately owned, federally chartered company whose debt has only implicit government support. Implicit means investors believe the government would rescue the GSE in a crisis, but no statute guarantees it.

Ginnie Mae (GNMA)

The Government National Mortgage Association (Ginnie Mae) is the only mortgage entity backed by the full faith and credit of the U.S. government. It is a wholly government-owned corporation inside the Department of Housing and Urban Development (HUD), created in 1968. Ginnie Mae does not buy or issue mortgages; it guarantees the timely payment of principal and interest on pass-through pools of federally insured loans (FHA and VA). Because of that guarantee, Ginnie Mae securities are treated as having the same credit quality as Treasuries.

Exam Tip: "Full faith and credit" plus "mortgages" always points to Ginnie Mae.

Fannie Mae and Freddie Mac

The Federal National Mortgage Association (Fannie Mae), created in 1938, and the Federal Home Loan Mortgage Corporation (Freddie Mac), created in 1970, are GSEs, not agencies. Both buy mortgages from lenders, pool them, and issue mortgage-backed securities, providing liquidity to the secondary mortgage market. Both are publicly traded and have operated under conservatorship of the Federal Housing Finance Agency (FHFA) since September 2008. Their debt and MBS carry implicit, not explicit, government backing, so they yield slightly more than Treasuries.

Other GSE Issuers

Federal Home Loan Banks (FHLBs)

The FHLB System is a network of regional banks, cooperatively owned by their member depository institutions, that provides liquidity for mortgage and community lending. The system raises money by issuing consolidated obligations (notes and bonds) that are the joint liability of the member banks. FHLB debt is a GSE security, not full faith and credit.

Farm Credit System

The Farm Credit System is a network of borrower-owned lending institutions that extends credit to agriculture and rural communities. It funds itself by issuing Farm Credit securities through the Federal Farm Credit Banks Funding Corporation. Like FHLB, it is a GSE.

Exempted Security Status

Agency securities are exempted securities under the Securities Exchange Act of 1934. This produces two exam-tested consequences:

• They are exempt from SEC registration and may be sold without a prospectus.
• They are NOT exempt from the antifraud provisions — misrepresenting an agency security is still illegal.

Do not confuse "exempted security" with "safe." The exemption concerns registration paperwork, not credit risk; a GSE security can still lose value.

Agency Tax Treatment

Unlike Treasuries, most agency interest is taxable at every level.

Mortgage agency securities such as Ginnie Mae, Fannie Mae, and Freddie Mac are fully taxable at federal, state, and local levels because the underlying cash flow is mortgage interest, not direct government debt. Certain non-mortgage GSE debt, notably FHLB consolidated obligations and Farm Credit securities, is treated like direct federal obligations and is often state and local exempt.

The Agency Spread

Because GSEs lack explicit backing, investors demand a small yield premium over comparable Treasuries — the agency spread. It is usually modest (a few basis points to a few tenths of a percent) and widens when investors fear credit stress, as it did sharply in 2008.

Exam Tip: Higher yield than a Treasury equals slightly higher perceived risk. The trade-off, not the absolute safety, is what the exam tests.

How Agency Securities Trade and Settle

Agency debt and agency mortgage-backed securities are quoted much like Treasuries — as a percentage of par, with agency debentures often quoted in 32nds. They trade over the counter through a dealer network rather than on an exchange, and the agency MBS market is one of the deepest and most liquid in the world; outstanding agency MBS run into the trillions of dollars across Ginnie Mae, Fannie Mae, and Freddie Mac combined. That depth is precisely why investors accept only a small spread over Treasuries.

A frequent distractor on the Series 7 is the difference between agency debentures (plain debt the GSE issues to fund itself) and agency pass-through MBS (claims on a pool of mortgages the GSE has guaranteed). Both are "agency securities," but the debenture is general corporate-style debt of the GSE, while the MBS carries prepayment risk because its cash flow comes from homeowners. Know which one a question is describing before you reason about its risk.